AIA, Axa eye derivatives, alternatives ahead of new solvency regime

Senior executives at the two life insurers shared how they and peers should adapt their investment portfolios ahead of Hong Kong's new risk-based capital regime.
AIA, Axa eye derivatives, alternatives ahead of new solvency regime

Investment veterans at AIA and Axa believe Hong Kong-based life insurers should allocate more to derivatives and alternatives assets, such as private equity and private debt, to mitigate the impact from a new risk-based capital (RBC) regime when it comes into effect next year.

Legal amendments for the new RBC regime are expected to be introduced in the legislative council in 2022, a spokeswoman at the Insurance Authority (IA) told AsianInvestor

The IA has already conducted three rounds of a quantitative impact study (QIS) to gather feedback from insurers on the new regime and is now developing detailed capital rules. The IA will conduct industry consultations later this year, she added.

The new solvency rules, modelled on Europe's Solvency II framework, aim to improve risk-based supervision and alignment with international standards but are also set to heavily impact insurers' asset allocations.

Trevor Persaud, AIA

"The emphasis of these developments in risk-based capital regimes is wholly positive in terms of the sophistication and precision needed to manage the asset-liability modelling and management process appropriately", Trevor Persaud, head of investment solutions at AIA Group, said in a panel discussion at Insurance Investment Week on Monday (March 15) hosted by AsianInvestor.

That said, investors are now in a "limbo period", where certain aspects that work with the new regime don't carry as much benefit, or in some cases, may result in negative impacts when compared with the old regime, he added.

"[To cope with the challenges], finding out how much capital will cost insurers under the new regime is stage one, and then stage two is working out where the charge comes leads investors to hedging strategies and a greater use of derivatives," Persaud said.

Ahead of the changes, insurers have been trying to "disentangle the engine for yield from the duration management perspective", which means investors need to use derivatives extensively, Boris Moutier, chief investment officer for Asia at Axa, added in the same panel discussion.

Boris Moutier, Axa

"It creates its own challenges; you need strong infrastructure. You need to consider all the impacts such as accounting and the like, but I think at the end of the day, it's still derivatives [that] have to be part of the toolbox", he said.

Rick Wei, head of Asia insurance strategy for global insurance solutions at JP Morgan Asset Management, explained how deploying derivatives for hedging could help insurers maintain better asset-liability management (ALM) and become more capital-efficient under the new RBC regime.

Insurers who invest massively in overseas markets have to swap back to a local currency, and interest rate derivatives can help build stronger ALM positions; thus, insurers can save a lot in terms of capital charge, he said. Equity hedging strategies can also help insurance companies in Asia who have a very high equity allocation to save a lot of capital and protect from volatility and downside risk, he added.

According to estimates by consultancy Oliver Wyman, Asian insurers who selectively employ derivatives to improve their ALM and invest more into alternative assets could unlock additional investment returns and help to raise their profits by a combined $3 billion over three to five years.

One way of doing so is by using exchange-traded and over the counter (OTC) derivatives on their long liability durations to take advantage of temporary interest rate mismatches,  Angat Sandhu, head of Oliver Wyman's Asia Pacific insurance practice, told AsianInvestor in October.


With the capital saved through the use of derivatives, insurers can potentially invest more in riskier types of assets like alternative assets to enhance yields, such as private equity and private debt.

Rick Wei, JP Morgan AM

"If I take Hong Kong [as the example] here, we see that the [capital] charges will be relatively high. But I don't think it means that we should stop all our programmes overnight. I think we should carefully consider the expected return and diversification and clearly maintain private equity," Moutier said.

Persaud agreed. "The private equity experience has been particularly good….Things like venture capital, where the ticket sizes are smaller and fewer of us have got experience, that's an area of interest because of its potential for slightly higher returns, but clearly only works in a diversified alternatives portfolio context," he said.

On the other hand, Persaud pointed out that items in the private credit space are more attractive to insurers not just because of the credit aspect but also in terms of return characteristics compared to the other return opportunities within the credit space.

"[It's the] extra return that you can get from illiquidity," he said, adding that skilled managers can help to make a "massive and significant difference" to return expectations of 100 basis points to 200 basis points, he said.

Private debt, including the high yield part of it, is also relatively capital effective and has proven to be quite resilient to the crisis, Moutier said.

AsianInvestor's online Insurance Investment Week conference will continue through this Friday. For more information, please contact Iain Bell.

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